The case for hedge funds in the throes of a crisis
Against the backdrop of financial markets across the world falling steeply in the wake of the Covid-19 pandemic, investors rushed to traditional safe havens in a bid to safeguard their investments
Comparing the current crisis to previous market corrections, it is worth recalling the collateral benefits of investing in hedge funds.
A hedge fund constitutes an investment programme whereby the managers or partners seek absolute returns by exploiting investment opportunities, while protecting principal from potential financial loss. Hence, the first hedge fund was a hedged fund.
As of the end of March, leading stock market indices lost in a range of between 13% -20% of their total value, with the MSCI World index (a popular equities proxy used to compare hedge fund performance) losing 14% of its total value.
The best-placed alternatives to offer defensive returns
Similarly, the value of a balanced portfolio (comprised of a 60% allocation to equities and 40% to fixed income investments) fell by approximately 10%.
Year-to-date values are worse still with leading equities having lost on average 25% and balanced portfolios nearly 15%.
During this same period, the average hedge fund has reportedly fallen within a range of between 4%-6% (depending on the data provider), while year to date, they are down approximately 7%.
As ever, performance dispersion exists with the top industry decile reporting gains of 20% while the lowest decile reported losses of 30%.
Put another way, hedge funds have managed to halve (or in some cases even more) the losses incurred by investors who have invested passively in equities or fixed income investments.
Looking at previous market corrections, hedge funds have consistently demonstrated they have been able to manage these periods for investors better than anyone else.
Taking the most recent example - the Global Financial Crisis of 2008 - where the 20% loss incurred by the hedge fund industry compares favourably to the average stock indices that lost half its value.
Further, the average hedge fund recovered its high-water mark (i.e. recovered its losses) by October 2010, whereas a balanced fund did not recover its losses until March 2013, some two and a half years later.
Arguably, now more than ever is an important time for investors to consider the case for hedge funds.
Tom Kehoe is global head of research and communications at the Alternative Investment Management Association
Bull points
• Hedge funds are designed to provide greater protection against the large drawdowns or peak-to-trough losses than the main asset classes sometimes experience
• Most hedge fund investors are pension funds and other institutional investors
Bear point
• Hedge fund strategies may seem difficult or complex to understand
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